The Capital Adequacy Ratio (CAR) calculator is a tool that you can use to determine a bank's ability to absorb credit, operational, and loan losses. This calculator uses several inputs that can be found on a bank's balance sheet. Using the inputs, the calculator will produce the CAR as a percentage. A higher percentage demonstrates a greater ability for a bank to cushion unexpected losses. Currently, the minimum CAR required is 8%. The Capital Adequacy Ratio is calculated using:
- Tier 1 Capital
- Tier 2 Capital
- Risk-Weighted Assets
Tier 1 CapitalThe Tier 1 capital is the core capital of the bank. Therefore, it can absorb losses without impacting business operations. It includes the most liquid and highest quality capital. Tier 1 capital is calculated by adding the common stock and retained earnings.
Tier 2 CapitalThe second component needed to calculate CAR is Tier 2 Capital. The Tier 2 capital, or supplementary capital, includes the less liquid capital of a bank. This includes undisclosed reserves, revaluation reserves, general provisions, and hybrid instruments.
Risk-Weighted AssetRisk-Weighted Asset is the sum of a bank's assets weighted by risk. The weighing of risk is based on the risk of the asset losing value. If there is a high risk that an asset will decrease in value, then it will have a higher risk weighting. Example of a high-risk asset is a loan or mortgage that is not backed up by collateral. This is because if the borrower is unable to pay back the bank, the bank has no way to collect on the loan.
FormulaThe formula for the Capital Adequacy Ratio is: CAR = (Tier 1 Capital + Tier 2 Capital) / Risk Weighted Assets As the Risk Weighted Assets increase, the CAR decreases as the bank's ability to absorb the loss in assets using capital decreases. On the other hand, as capital increases, the bank's ability to cushion unexpected loss in assets increases and so does the Capital Adequacy Ratio.